The Global Reporting Initiative released a report Wednesday urging companies to take a due diligence approach in their sustainability efforts.
The paper explains how due diligence policies set expectations for all types of corporate behavior, not just for sustainability. Topics such as tax, procurement, corruption and human rights are likely to be included in the due diligence rules.
Public reporting is necessary for the effective implementation of due diligence, according to GRI, a Netherlands-based organization that has a set of sustainability standards widely used in Europe. GRI also collaborates with the International Sustainability Standards Board on developing environmental, social and governance standards. Such disclosures need to cover a broad range of related areas — including governance, supply chain impacts and operations — which is why a widely adopted reporting regime is required.
There has been something of a backlash in recent months against ESG funds in several states like Florida and Texas, and last week President Biden issued his first veto to defend a Labor Department rule that allowed retirement plan and pension fund managers to consider ESG and climate change factors when making investment decisions. However, many investors and fund managers in Europe and other parts of the world are in favor of ESG investing, as are many in the U.S. despite the recent political pushback.
GRI CEO Eelco van der Enden spoke to Accounting Today about his organization’s efforts to promote ESG and sustainability during the Ceres Global conference on sustainable finance last week in New York.
“In most countries, investors, but also businesses, see this as longer-term risk management,” he said. “There is global warming. That’s a fact, and you have to do something about it. There are social issues and workforce issues that need to be addressed in order to keep the shop open. And there are issues around governance that are serious, that should be taken care of, like anti-bribery or money laundering. These are all topics that deal with the letters E, S and G, and are part of the fiduciary duty that board members have in order to protecting the investments of long-term investors like pension funds and institutional investors, but also to take care of the safety of their employees and their families, and make sure that there are no going concern issues of bad governance. That is something that is now a common understanding, which is not a political issue, but is just doing good business in a proper way.”
Some of the banks that failed in recent weeks like Silicon Valley Bank were favorably viewed by ESG fund managers and that may have exposed investors to risk, but ESG is likely to be a trend that’s here to stay, especially as climate change continues to contribute to natural disasters in the U.S. and abroad.
“It’s a question of proper risk management,” said van der Enden. “Where do you put your assets? If you put all your assets only in funds with a specific ESG tack without taking any other topics into consideration, that would not be that smart, [nor] if you ban firms that have a certain ESG tack.”
He also disputed claims that SVB may have collapsed because the bank took steps to ensure board diversity. “I don’t see a correlation between banks collapsing and ESG,” said van der Enden. “I see banks collapsing over bad management and bad governance and a bad job by supervising organizations that should have been monitoring more closely what the portfolio of the bank was.”
Public reporting is necessary for the effective implementation of due diligence, according to the GRI report. Disclosure needs to cover a broad range of related areas — such as governance, supply chain impacts and operations — signaling why a widely adopted reporting regime is required. Due diligence considerations are playing a growing role in financial decision-making. The impacts identified through the due diligence process can be included within enterprise risk management systems, the report suggested, and serve as an input for identifying financial risks and opportunities.
Auditors have been blamed in part for not taking into account more of the financial risks at banks like SVB and Signature Bank, which were both audited by KPMG and the firm issued clean audit opinions only about weeks before they collapsed, as it did for First Republic. However, it may be too tempting to blame the auditors for what appeared to be healthy banks until investors got nervous and started withdrawing their deposits all of a sudden.
“Independence and proper audit work are of course key for trust in an economic system and the financial system, but we have seen companies go bankrupt before sustainability became a topic,” said van der Enden. “It will be very strange now to claim that sustainability is the reason why companies go bankrupt.”
Indeed there has been considerable demand for sustainability investments, especially in light of the tax incentives for electric vehicles and other forms of clean energy technology in the Inflation Reduction Act that Congress passed last year.
The GRI report found that due diligence in sustainability isn’t possible without good supply chain mapping. Effectively assessing potential impacts linked to a company’s products, including use of raw materials, requires transparent and traceable supply chains for better sustainability.
“It affects the entire supply chain on a global scale,” said van der Enden. “It is not so much about ESG. It is a transformation of the global economic model. Some priorities must be set a bit higher than others, but that always has been the case in managing a business. When you see that certain risks are going to pop up, you have to mitigate them. In Europe we have a workforce that is getting older, so we know we will have a shortage in the future of younger employees. In dealing with it and the demographic effects, is that ESG that you want to attract the scarce staff available by presenting yourself as a social employer? I think it’s smart because you get the best, the youngest and the smartest. High-risk organizations that don’t will face a problem in the labor market.”
Interest in combating climate change and promoting greater sustainability could be one way to attract more young people to the accounting profession, which has been facing a pipeline shortage like many other sectors of the economy.
“I have a background in business and at PwC,” said van der Enden. “Working on an entire value chain needs a more holistic view and approach than only looking at the financials. I personally find it far more interesting, and I know most self-starters also look more at what’s happening in the world and in their direct environment. They have been raised with concerns over climate and pollution and human rights. It’s pretty much true that they prefer working like that. What we see in the larger accounting firms is that there may be perhaps a bit of a slump in some of the services rendered, but there’s still a huge shortage of people that work in the sustainability business.”
Some accounting firms have been providing assurance services for sustainability reports, but that too can lead to risks for firms that don’t pay sufficient attention to what’s happening on the ground in the businesses whose sustainability practices they’re vetting. The International Consortium of Investigative Journalists recently reported on how some ESG assurance providers and auditing firms haven’t been properly assessing the claims of some forestry industry companies in Canada before stamping them as certified by a sustainability group.
Assurance providers need both independence and qualified people. “A standard-setter or green badge provider should never be the organization that’s also performing the audit,” said van der Enden. “I think that is unhealthy. You should split them. We at GRI set standards and we get many questions on how we go in to assess that the standards are well used. That’s not our task. We are not equipped for that. That’s the task of the accountants.”
He pointed to a report last month from the International Federation of Accountants and the Association of International Certified Professional Accountants on progress on assurance and sustainability (see story). “I was happy to see that 40% of all GRI published reports were accompanied by external assurance, which is quite interesting,” he said. He noted that for reports based on guidelines from the Sustainability Accounting Standards Board, the figure was only 7%. He wonders why the level of assurance isn’t higher on the more financially oriented reports based on SASB standards and perceives a different attitude toward sustainability assurance in the U.S., where SASB standards are more widely used, compared to Europe, where GRI’s standards are heavily used. The European Union’s Corporate Sustainability Reporting Directive aligned European Sustainability Reporting Standards more fully with GRI’s standards, according to the European Financial Reporting Advisory Group.
While SASB, the International Integrated Reporting Council and the Climate Disclosure Standards Board have now been consolidated into the new International Sustainability Standards Board, GRI is staying independent, but still acting as an advisor to the ISSB. The ISSB, which is part of the IFRS Foundation that also oversees the International Accounting Standards Board, proposed a set of sustainability and climate-related disclosures that are largely based on the SASB standards. Once the standards are finalized next year, and the Securities and Exchange Commission moves forward with the climate-related disclosure rule it proposed last year, there may be wider adoption of sustainability reporting standards in the U.S. and abroad. That may include so-called Scope 3 reporting, which would require reporting of emissions from a company’s vendors, suppliers and even customers. However, Scope 3 reporting may well be dropped from the final version of the SEC rule on climate disclosures when it’s eventually issued after the SEC takes into account the thousands of comments it received on the proposed rule.
“I think ISSB standards will become mandatory in many jurisdictions, like the standards of their sister, the International Accounting Standards Board, so there will be a bigger uptake,” said van der Enden. “We see pressure from investors to start reporting more comparable data on sustainability topics, and there is a widespread consensus in most companies that this type of information is also important to stay relevant within the societies and communities where you operate, in attracting staff, your relationship with local governments when it comes to licenses, when it comes to attracting your clients, and having a special relationship with your suppliers. We see the Scope 3 reporting in the SEC proposals as with the ISSB, EFRAG and GRI. That will basically mean that suppliers or clients also need to provide certain information on emissions or human rights. The organization they ask that information from needs to provide that information. If they don’t have that information, they need to get it, and if they have it, why shouldn’t they report on it themselves? You will see a trickle-down effect through the whole supply chain, so the uptake will be massive.”